Shares of Ziopharm Oncology (ZIOP) plunged by 65% to $1.82 on Tuesday when it released news that its only late stage drug candidate failed to meet its primary endpoint. For now, there isn't much of a play except for those who may wish to bet on some further downside.
No one can truly predict in advance the outcome of Phase III trials; however, with Ziopharm there were a steady stream of clues that investors should be skeptical about its prospects. At $2.00-$3.00, some investors could have been justified in investing in Ziopharm, but at nearly $6.00 the risk / return profile became downright silly.
Although I am currently working on my next report, I thought it would be useful to weigh in on how investors can try to avoid the next Ziopharm or at least minimize the damage from it.
The purpose of this article today is not to say "I told you so." Instead the purpose is to highlight the areas where investors went wrong and to hopefully allow investors to avoid similarly large losses in the future.
The lessons to be learned from Ziopharm are as follows:
Lesson 1 - Be wary of low institutional ownership
During its life, Ziopharm was always a stock with low institutional ownership. A few years ago, famed billionaire and genius biotech investors Randal Kirk began investing in Ziopharm, which in turn attracted Fidelity to invest. Aside from these two players, Ziopharm remained a largely retail stock for a long time.
There is nothing wrong with investing in retail dominated stocks, but they should certainly require a discounted price. Institutional investors deploy armies of well-trained analysts and vast amount of financial resources for one single purpose: they want to make money.
In most cases, if a certain stock presents a compelling value opportunity, it will certainly attract institutional attention. The lesson to be learned is that retail stocks which trade at premium valuations are very dangerous. It is better to wait and buy in at a time when the share price is weak rather than chase the valuations higher. If no such opportunity presents itself then it is best to not play at all.
Lesson 2 - "Who wants to be a billionaire"
Investing has always been difficult and there are no easy formulas for making money. Individual stocks must stand upon their own merits.
Yet with Ziopharm, we can see that droves of retail investors simply took the view that if they bought what Randal Kirk had bought then they could get rich too.
Anyone who has followed Kirk's investing career knows that Kirk should really be considered a genius within the world of biotech. However, in the case of Ziopharm, the prospects of the company simply did not match up to the share price.
This is not a case of 20/20 hindsight just because the drug failed. Prior to its failure, Ziopharm could have been considered (by some) to present a sensible risk/reward profile at $2.00-$3.00.
In trying to make themselves mini-billionaires, many investors seemed to ignore the fact that Kirk has invested on terms which were different than the rest of the market, obtaining an in-price of just $1.91.
This was true even though he continued to buy lesser amounts of shares even at prices above $5.00.
Kirk is currently using Ziopharm as a vehicle to advance his Intrexon drug technology. As a result, with Ziopharm now sitting at multi-year lows below at $1.82, he may even consider buying the entire company to further that goal. This will be of small comfort to anyone who was paying over $5.00 last week.
For a billionaire investor, it is largely irrelevant whether he purchases the remainder of the company at $1.00 or at $6.00. He will still own the entire company and will still have plenty of money to spare.
The key lesson to be learned is that if you're not a billionaire then don't try to invest like one.
Lesson 3 - Don't shoot the messenger
I first wrote on Ziopharm back in October of 2012 following several months of research. The share price dropped by more than 30% to below $3.30. Yet Ziopharm issued an aggressive response and the share price rebounded to well above where it was prior to my article.
Investors may now want to ask themselves "what sort of response would you expect from the company?"
Of course, investors would not expect a company whose share price is falling to release a statement that says "the shorts are right." Nor would we expect the company to say nothing. Instead, Ziopharm did what was expected and put forth a statement that assembled as many positive data points as possible without actually refuting a single point that I had made.
At that time, investors were in a uniquely advantageous position. They were now in possession of substantial amounts of negative information and yet were able to sell at a price which was actually higher than when the information was released.
The lesson to be learned is that investors should evaluate all new information based upon its own merits and not unfairly discount new information because it is negative or because it contradicts the investor's original opinion. Investors can avoid substantial losses by giving a fair evaluation of opinions from people who hold drastically opposing views.
Lesson 4 - Retail oriented stocks are wildly market-inefficient
Back in November, Ziopharm announced that results of its upcoming Phase III trial would be delayed until March. This was the case even though as late as October Ziopharm had continued to tell investors to expect near-term results. The delay caused Ziopharm to begin a moderate (rather than speedy) descent to below $4.00 within the coming 8-12 weeks.
Yet as the key March deadline approached (and as risk increased), the share price skyrocketed to nearly $6.00.
It is quite clear that many investors regarded the rising share price as a market-efficient vote of confidence that results would be good. Instead, what really happened is that more and more retail investors simply hopped on to a fast moving train at ever increasing speeds. It was a classic self fueling and market-inefficient bubble.
Likewise, when the stock rebounded following my initial negative article, many retail investors simply decided that the conclusions could simply be disregarded because the "efficient" market had already cast its vote.
The lesson to be learned is that retail-driven stocks are subject to periods of euphoria where investors are simply looking for any new reason to buy a stock while disregarding sell signs which become increasingly obvious.
Lesson 5 - The shorts might not be as stupid as you think
Hopefully it will not escape the attention of most readers that Ziopharm did in fact have a meaningful institutional presence. But rather than being long, these institution were overwhelmingly short Ziopharm and in sizeable amounts.
When my article was released in October, many retail investors began posting on bulletin boards that it was just a transparent ploy by which shorts were hoping to exit a skyrocketing stock in which they were trapped.
Yet when the subsequent short interest numbers were released, it could be seen that short interest actually increased slightly rather than decreasing.
The conclusion to be had was that rather than scampering to exit a stock in which they were trapped, the shorts had tremendous conviction. Rather than covering their short position with a gain of over 40%, they waited until the final results due to their certainty that fair value was in fact far lower.
The only thing more dangerous than investing in a retail-dominated stock is investing in a retail-dominated stock with a huge short interest ratio. Short investors tend to overwhelmingly be institutional rather than retail and have the resources to conduct research which is far more thorough than what they refer to as "dumb retail."
On the short side, potential losses are unlimited. An investor who was short Ziopharm could easily have lost 100% or even 300% of his initial investment. Even now that they have been proven right, short investors are still only making around 65% vs. the recent prices in the $5.00 range.
This is the exact opposite of long investors who stood to make several hundred percent gains with no cost of borrowing shares and with a fixed limit to their downside.
As a result, those investors who chose to get short Ziopharm needed to do a tremendous amount of work to get comfortable with their position. The fact that the short interest was very large meant that conviction was very large and was backed by sizeable institutions.
In fact, when put up against this, it seems that retail simply didn't stand a chance.
The lesson to be learned here is that shorts are not dumb investors. In fact, by necessity they need to be significantly smarter than long investors with most of their position. This applies doubly so to volatile healthcare and biotech stocks. If the short interest is high in a stock with low institutional (i.e. long) investment - then stay away.
Lesson 6 - Don't get Charlie Browned
Every time Charlie Brown made a full speed run towards the football, Lucy would pull the ball away and Charlie Brown would land on his head yelling "ugh!" Not long thereafter, Lucy would again hold up a football and Charlie Brown would once again run full speed, learning nothing from his previous pain.
The failure of Palifosfamide was not the first disappointment from Ziopharm, instead it was just the most dramatic. As I noted in a previous article, Ziopharm had for years been delivering failures and breaking promises. But in each case Ziopharm would come up with a newer and better reason to hype the stock. In each case, Ziopharm would hold up the football and say "trust me Charlie Brown, this time it's different." Retail continued to run at the ball full speed.
Now once again, Ziopharm is attempting to divert the attention of investors away from the failed Palifosfamide and on to its new and compelling DNA platform in connection with Randal Kirk's Intrexon. Investors will once again have the opportunity to run full speed while Ziopharm holds the football for them.
When a company delivers failures, its stock should trade at a discount until it delivers some form of concrete proof that it can really deliver more than just a new set of promises and hope.
Lesson 7 - The dangers of group-think
At some point in the life of a stock, it becomes a great time to sell. This is the case even when one likes both the company and the product. This is just another way of saying "buy low, sell high" will always beat "buy low, sell never."
Yet retail stocks are prone to both group-think and cheerleading. With Ziopharm, it was consistently the case that a small number of vocal authors would shout down any hint of criticism no matter how well founded. As the share price rose, these authors would simply increase their level of optimism to an ever higher share price target. According to these authors, the right time to sell Ziopharm was never.
The uber-bullish authors have every right to express their opinions and every right to invest in line with those opinions. However, it is up to the rest of us to determine if they have drank too much of their own Kool Aid and if they are indiscriminately shouting down useful information about when to exit the trade.
The lesson to be learned is that when a small number vocal authors continue to pump a stock at higher and higher prices while disregarding any suggestions to sell, then that is probably a good time to get out before the stock corrects.
Again, the purpose of this article is not to say "I told you so" and it is not a case of 20/20 hindsight. Instead it is my hope that investors who are tempted to chase the next great retail lottery ticket may think twice about some very obvious risk factors.
Oftentimes there is a very good reason why institutions have passed on owning a given stock and have left it overwhelmingly in the hands of retail investors. In many cases, some institutions may have been early investors, but then exited when retail investors pushed the price up to irrational levels.
When the only institutions who have interest in a stock are overwhelmingly interested on the short side, retail investors should start to question whether they are really investing on a level playing field. They need to ask if they have the information and the resources to fully understand a complex situation and to accurately monitor any new developments. In most cases the answer will be no.
In the case of Ziopharm, the company had delivered a stream of disappointments and broken promises yet it still retained a fanatical following among retail authors and investors who kept assuring one another that the right time to sell was never.
If investing was as easy as simply riding the coat tails of famous billionaires, then the rest of us could all become billionaires too. But as we can see from Ziopharm, billionaires seldom get that way by making open market purchases at all-time-high prices. When Randal Kirk continued to buy Ziopharm at prices above $5.00, many retail investors assumed that tremendous further upside was virtually guaranteed. Yet following the recent 65% plunge in the stock, Kirk is now showing a paper loss of only 5%. The lesson here is: that's why he's a billionaire and the rest of us are not.