The stock price of Vertex Pharmaceuticals (VRTX) spiked up 3% in early Wednesday trading after the company announced its Q1 2013 financials the previous evening, beating analyst expectations on revenue and net earnings. However, by the end of the day VRTX gave up all but one penny of its gains to close at $76.83. Perhaps investors saw through the beat of very low analyst expectations as the company's revenues still declined 25% from Q1 2012 and were slightly lower than Q4 2012 revenues. Also to accept the 3 cent EPS for the quarter you have to ignore the $413M write-off of its intangible hepatitis C asset VX-222 (offset by the associated tax benefit of $128M).
Further to my article on April 24, insiders have continued to sell large amounts of the stock as Christiana Stamoulis joined Paul Silva and Ian Smith in exercising options and immediately selling the shares on to the market. Stamoulis sold 83K shares at $79.08 after exercising 78K at $33.82. There was further insider selling to the tune of $6.6 million on May 1 so expect the Form 4 to be updated with these insider sales shortly.
The most transparent driver of the insiders selling the stock would be the imminent exercise of the company's convertible debentures. Reading the latest financials, you can get a glimpse of the debenture terms. The terms are quoted as follows, "As of March 31, 2013, Vertex had $400.0 million in convertible debt due in October 2015. The conversion price of the debt is $48.83 per share and is callable on or after October 1, 2013. Vertex holds a provisional redemption option that allows the debt to be called prior to October 1, 2013 if the closing price of Vertex shares is above $63.48 per share for 20 of 30 consecutive trading days."
Referring to the conference call transcripts, Smith said on the call that the company likely intends to call the debentures in. Quoted as follows, "Sometimes people aren't aware of that, but it does have a soft call feature that if the debt trades just above $63 for 20 days out of 30, then we do have the opportunity, and we'll have the intent to convert it into equity. So we're happy with maybe having that opportunity in the near future to convert the debt into equity, which is all consistent with kind of the broad financial strategy of managing the P&L".
In a low interest rate environment where VRTX will struggle to be profitable in the near term and is paying the interest payment associated with the debentures out of company funds it is clearly a good idea to call in the debt. But with that comes dilution of the shares.
Some debenture holders will be perfectly happy to take the shares. But others may be part of a debt only investment fund where the holders will be forced to sell the shares. Others would prefer to sell the shares because they will no longer receive a cash return on their investment as VRTX is years away from being able to pay a dividend. And some others would sell the shares because they are more than happy to take a $25-$30 or so per share capital gain on top of the interest they have earned. Any holder with foresight knows that the call in is imminent as VRTX only needs to stay above $63.48 for the next two weeks before the debentures become eligible to be called in. There is an incentive for these investors to short VRTX stock now and cover with the shares that they get during the conversion. Upon conversion, there will likely be further selling pressure as those investors who did not short but also don't want to hold the stock will sell at that time.
No matter what you think of the long-term prospects of Vertex, there is no more obvious short play on the market here and now than VRTX. The company is directly telling you that it intends to dilute the shares through the conversion of the debentures at $48.83. It is also showing you what they think will happen to the stock price upon conversion as the insiders are exercising their options and selling their shares, pocketing millions of dollars now while they can. The selling pressure could be very strong on VRTX over the next couple of weeks and there is a very good chance if you sell VRTX now, you will be able to buy the shares back cheaper by the end of May.