Biotechnology companies offer the opportunity to achieve lofty returns but also have the potential for complete failure. It takes a complete understanding of the science, the upcoming catalysts, and the fundamentals to understand which companies may succeed. Below are three companies that I believe offer that potential for success, but before I discuss them, let's look at a few recent examples of the high levels of volatility that small cap biotech investing can throw at you.
The Potential Volatility Of Small Cap Biotech Investing
Keryx Biopharmaceuticals (KERX) is an early stage biotech company that had been focusing on developing a treatment for kidney disease, called Zerenex. That chart below demonstrates what positive drug trial results can do for a company.
The stock actually went up several hundred percent before settling a little lower. The official announcement came out on January 28, 2013, when Keryx revealed that its late stage study showed that Zerenex had performed much better than a placebo. Keryx also revealed that it would submit an application to the FDA for approval during the second quarter of 2013.
Now on the flip side, there can also be biotech disasters. Ziopharm Oncology (ZIOP) unfortunately cost its investors a great deal of money when it announced that its Phase III trial for soft tissue sarcoma had not met the primary endpoint and the company would cease future development on that particular treatment. As the chart below shows, it was an ugly day for investors.
These two case studies show us that explosive moves can happen, but they may not always be in investors' favor. Here's hoping that what happened to Keryx will also happen to the following 3 companies.
Company #1: ImmunoCellular Therapeutics (IMUC)
ImmunoCellular Therapeutics is an early stage biotech company focused on developing and commercializing new therapeutics to fight cancer using the immune system.
The company's products are designed to harness the power of the immune system to improve the treatment of cancer. ImmunoCellular is developing active immunotherapies that target not only regular tumor cells, but also the cancer stem cells believed to cause cancer growth and recurrence. The company's proprietary discovery technology allows it to identify and develop monoclonal antibodies that may be used to treat a wide range of cancers.
The product I am most excited about from ImmunoCellular is ICT-107. This product is currently in a Phase II study and is a vaccine used in the treatment of glioblastoma multiforme (GBM). The company already successfully completed its Phase I trial, which showed prolonged survival with little to no side effects.
Besides the above product, which has a lot of potential, the company has an incredibly deep pipeline of products that can be used to treat a variety of cancers.
Clearly, the ICT-107 study is the furthest along in development and the company expects to update investors by the end of 2013. Investors are banking their hopes on this particular study and investors need to know the explosive potential and/or risk involved here. The stock currently trades at $2.42 and as such, carries a market capitalization of just $123 million. Phase II results are due out by the end of the year, most likely in the fall sometime. We can turn to the option markets to get a sense of what kind of move the market expects. The November 2.5 Straddle (2.5 Put plus the 2.5 call) is currently trading for $1.20. That is half of the current stock price. In other words, the market anticipates the stock falling to at least $1.20 or rising up to $3.60 by the end of the November option expiration period. So basically, we should expect a 50% move either to the upside or downside.
Technically, ImmunoCellular has had an interesting trading period. Over the past 2 years, the stock has appreciated by about 30%, but not without some incredible volatility.
Over the past year, the stock has essentially traded sideways.
But over the past 6 months, seems to have recovered nicely and shown significant strength.
It's hard to tell what these 3 charts tell about the technical picture but one thing is clear, trading here is not for the faint of heart and appears difficult to time.
ImmunoCellular has a fairly strong financial position for a company so early on in the process. The company reported its financial results for the year and quarter ended December 31, 2012. For the quarter ended December 31, 2012, the company generated net income of $484,000, compared to a loss of $1,499,000 for the same period a year ago. The company also reported that it had $26.2 million in cash as of the end of 2012, which is a large increase over the $6.7 million it had in 2011. Although the company did issue equity financing during the year, it nevertheless remains sufficiently funded to complete its trials in the future.
In addition, the company has very little debt (both long- and short-term). The last thing investors want to worry about is having to make interest payments each quarter. Instead, the company can focus on what it should be focused on, completing its trials successfully. An additional positive is that the company has an extremely low burn rate of just $4.8 million per year.
The one blip on the radar was the net income number, which came in at a loss of $14.5 million. The loss number expanded by roughly $8.8 million from a year ago. This was mostly due to increases in research and development so it's not overly concerning, but it still needs to be taken into account.
Company #2: Sarepta Therapeutics (SRPT)
Sarepta Therapeutics is a development stage biotechnology company that is primarily focused on the discovery and development of ribonucleic acid based therapeutics for the treatment of rare and infectious diseases. Its flagship product is Eteplirsen, which is used to treat Duchenne muscular dystrophy.
Investors in Sarepta have seen their portfolios advance by significant amounts over the past year. The chart below shows the kind of run that Sarepta has been on.
As the chart shows, the stock really began to rise during the summer of last year. Sarepta announced that its Phase II trial for Eteplirsen had shown a clinical benefit. The trial indicated that Sarepta's drug had showed a 69.4 meter benefit over patients who only received the placebo. More recently, Sarepta also announced that Eteplirsen's benefits continued through 74 weeks in the walking test. This was a great press release, as some investors had concerns that the drug's effects may wear off over time.
In March/April, Sarepta met with the FDA to determine if Eteplirsen could be granted accelerated approval. On April 15, Sarepta revealed that the FDA did not grant outright permission to file for accelerated approval, but required more data. The FDA wants Sarepta to submit a summary explaining why dystrophin, the production of which is supposed to be stimulated by Eteplirsen, is an acceptable therapy for DMD. The FDA also wants detailed information about the clinical trials of Eteplirsen, and indicated that it would need the information in order to determine if the drug is eligible for accelerated approval.
Analysts from Piper Jaffray believe that this indicates that the FDA is trying to find a way to get this drug eligible. It meets a huge need in the market and would represent a significant breakthrough in modern medicine. Analysts have put a $50 price target on Sarepta.
Sarepta has said it expects to provide the data to the FDA by the end of the second quarter and should hear back regarding accelerated approval at some point during the third quarter. This decision should send the stock either soaring or possibly below $20, which some analysts, including the ones from Piper Jaffray, say would represent a buying opportunity for longs. In fact, we can look at the option markets, much like with ImmunoCellular, to get an idea of what kind of impact the official FDA ruling will have. The ruling is expected by the end of the third quarter, so we can use the November options, since that is nearest term that includes all the time up until the end of September. With the stock trading at $33.08, let's use the November 33 straddle. It currently trades for $16.75, which means the market expects the stock to trade as low as $16.25, or high as $49.80 by the end of the November expiration period. This essentially means we can expect to see a 51% move because of the accelerated approval decision. That is explosive!
If we switch gears and turn our attention to the financials, Sarepta has managed to do some nice things. Sarepta reported its fourth quarter earnings on March 7, 2013. For the fourth quarter 2012, Sarepta reported an operating loss of $10.4 million, compared to just $9.0 million for the same period in 2011. However, this was mostly due to a loss of a government contract, which resulted in a roughly $6.3 million revenue stream. Putting that aside, the company managed to decrease corporate operating expenses by $4.9 million.
Revenues for the fourth quarter 2012 came in at $7.3 million. This was down by $6.3 million from the same period a year ago. This was due to the loss of the Ebola Marburg U.S. government contract. This was not due to any fault of Sarepta, but rather because of a lack of U.S. government funding.
Sarepta does face two serious risks. First, there is a big chance that the FDA may not grant accelerated approval and the stock will see a large sell-off on that news. If that happens, the stock would likely drop to the low 20s, and possibly lower. At that point, investors would have to hold for the long haul until the company can navigate through Phase III and eventually face an FDA approval panel. A second big risk is competition from GlaxoSmithKline (GSK). Glaxo's competing product is called Drisapersen. One problem for GlaxoSmithKline is that Drisapersen had some safety issues, including tolerability and toxicity. These safety issues may have an impact on Eteplirsen's accelerated approval potential or they may not -- it's up in the air at this point.
Although the risks are very real for Sarepta, I have to believe that even if accelerated approval isn't given, the company is still a buy. It will own the muscular dystrophy market if successful and will most likely see a huge upward move should it be successful.
Company #3: NeoStem, Inc. (NBS)
NeoStem, Inc. is a leader in the emerging cellular therapy industry. The company is involved in the development of novel proprietary cell therapy products as well as a contract development and manufacturing organization that provides services to others in the regenerative medicine industry. The combination of a therapeutic development business and revenue-generating service provider business provides NeoStem with capabilities for effective in-house product development and immediate revenue and cash flow generation.
The company is currently developing an active and exciting portfolio of product candidate assets based on a diverse array of technology platforms. A few examples are:
- Amorcyte (AMR-001): Autologous bone marrow-derived adult stem cells targeting the substantial market of cardiovascular treatment
- Athelos: T-cell therapeutic targeting autoimmune conditions
- VSEL Technology: Pluripotent adult stem cells that can regenerate tissues and potentially treat conditions ranging from macular degeneration to liver regeneration to osteoporosis
Amorcyte's flagship product is AMR-001, used in the prevention of major adverse cardiac events following acute myocardial infarction (AMI). The company has been enrolling patients in the PreSERVE AMI Phase II trial since January 2012. On March 7, 2013, the company received approval to continue the Phase II trial for AMR-011. NeoStem intends to enroll 160 patients in a placebo controlled, double-blind study. A composite of cardiac measures, including clinically meaningful endpoints, will support the primary endpoint of perfusion.
Another area of NeoStem's business that I find extremely fascinating is VSEL Technology. There are 5 current areas of study that are taking place in this division covering bone regeneration, the eye, wound healing, sciatic nerve regeneration, and radiation exposure.
- Bone Regeneration: In collaboration with the University of Michigan, NeoStem is attempting to show that VSEL Technology can be used to treat osteoporosis and periodontitis. The company has received grant funding for these studies totaling approximately $3 million.
- Eye: In collaboration with the Schepens Eye Research Institute (an affiliate of Harvard Medical School), the company is attempting to demonstrate that injected VSELs in the eye can mitigate and integrate into areas of damage. This can be used for indications such as macular degeneration and glaucoma.
- Wound Healing: In collaboration with Roger Williams Medical Center of Rhode Island, NeoStem is using VSELs to demonstrate healing of mouse tail wounds across all dermal tissue layers with minimal scarring. This can be used to treat chronic wounds and battlefield wounds.
- Sciatic Nerve Regeneration: In collaboration with the University of California at Berkeley, NeoStem is beginning initial studies in nerve regeneration. The hope is to prove that stem cells contained in nano tubes can regenerate the severed sciatic nerves of rats. The company is currently awaiting the results.
- Radiation Exposure: In June 2012, NeoStem was awarded a two year grant in the amount of $595,252 from the National Institute of Allergy and Infectious Diseases, a division of the National Institute of Health. The award will fund studies to investigate the potential of very small embryonic-like stem cells as a countermeasure to radiological and nuclear threat. The product candidate, which is an autologous stem cell therapy derived from the patient's own stem cells, will be developed to rescue patients who have been exposed to radiation due to nuclear accident or terrorist threat. It will also be able to treat cancer patients who have undergone radiation therapy and who consequently have compromised immune systems.
One thing I really like about NeoStem is the fact that it has taken significant strides to improve overall fundamentals. For a stem cell company such as NeoStem, one of the most important areas to look at is the amount of cash on the books. At the end of 2012, NeoStem had a cash position of $13.7 million, an increase of $9.8 million from the end of 2011 when the company only had $3.9 million. The company was also able to reduce long-term debt by approximately $200,000 from 2011 numbers. At the end of 2012, NeoStem only had long-term debt of $273,000. The company was also able to reduce a category called "other liabilities." This number stood at $29.5 million at the end of 2011. The company paid off $21.8 million of that and only had other liabilities of $7.8 million at the end of 2012. So the balance sheet looks extremely strong with the company growing its cash, and at the same time, reducing long-term liabilities.
If we turn our attention to the income statement, we will see that NeoStem is again making all the right moves. NeoStem was able to generate total revenue of $14.3 million in 2012, an increase of $4.3 million from 2011 levels. Additionally, the company was able to improve its operating loss despite spending an additional $3 million in research and development. The operating loss for 2012 came in at $30.4 million, an improvement of $3.6 million from 2011.
In addition to the strong financials, now may be the right time to invest due to an error in the news media. On April 29, 2013, GlobeNewsWire incorrectly reported that NeoStem was going to issue additional common stock to the public. This was an incorrect announcement and NeoStem came out and issued a press release to clarify that the company will indeed not be issuing any shares at this time. The stock fell off about 15% on the incorrect announcement and I would expect the share price to bounce back once the public soaks in the new information.
Lastly, NeoStem recently announced that one of its subsidiaries, Progenitor Cell Therapy, would partner with MedStar Georgetown University Hospital to provide autologous and allogeneic cellular therapy services. MedStar Georgetown University Hospital intends to use the services of Progenitor Cell Therapy for processing and storage of peripheral blood progenitor cells, donor leukocytes, bone marrow and cod blood, as well as requested assaying and storage of cellular therapy product, and retrieval and transportation logistics. I would expect this deal to help contribute to NeoStem's futures earnings.
As good as the company appears, it's always important to note the risks. My biggest fear for NeoStem is additional secondary offerings in the future. As an early stage stem cell company, cash is king. And although the company did end 2012 with almost $14 million cash on hand, it may need more in the future to continue funding operations. Additionally, the stem cell industry is extremely competitive and there are a variety of companies trying to treat different indications using stem cell research. However, even knowing that, NeoStem appears to be making all the right moves to put itself in position to be a major player in the industry.