"It's easier to conjure up conspiracy theories than to understand how biotechs are actually built." - biotech executive
A recent SeekingAlpha article presented The Street Sweeper's case for shorting Coronado Biosciences (CNDO). The piece opened with scathing words, stating that CNDO "is tangled amid a bizarre whipworm therapeutic candidate, jail birds, cozy relationships, crazy financing, decimated companies controlled by a master puppeteer - and just now a brand new $200 million shelf registration."
The report backed up those words with a set of facts that painted an ugly picture of the company, its product, and its management. The account was so compelling, I immediately shorted the stock.
For the record, I am not an advocate of acting solely on a third-party analysis (even my own) -- quite the contrary. However, in this case, the story was compelling enough that I thought investors would quickly short the stock. That made it a good trade while enlisting analysts at PoisedToTriple to research the merits of betting against CNDO.
Not being experts in biotechnology, our due diligence began by reaching out to contacts that are. We asked them to read the original report and provide feedback. This is reminiscent of the approach that Carl Icahn took with Bill Ackman's report on Herbalife (HLF). As discussed at the 2013 Delivering Alpha conference, Icahn wasn't familiar with the dynamics that would impact whether or not the FTC would become an issue for HLF. To rectify that, he simply sought the opinion of a reliable and independent expert.
In this case, our experts included industry leaders and analysts with whom we have consulted for many years. They are trustworthy and have no vested interest on either side of the argument. Net-net, they were universally skeptical. However, one comment stood out -- "Just be careful. It's easier to conjure up conspiracy theories than to understand how biotechs are actually built."
Taking that comment to heart, we decided to play devil's advocate by parsing the report and judging each aspect of the short case, point by point. Here's a rundown of the bearish items we think investors should dismiss:
1) CNDO filed an S-3, indicating that the company will seek to raise funds…just before its latest round of clinical trial results are released. On the surface this sounds very bearish. However, we found that companies often raise money ahead of Phase III data. It's not necessarily because they think the study will fail. If the valuation is fair, the funding can serve as a hedge (insurance against a negative result) or help to jump start the product's launch (in anticipation of a positive result).
Under either scenario, it can be argued that raising some funds before Phase III results is prudent. By extension, having a valid shelf registration is also a good idea for such companies.
2) The fact that CNDO's candidate generates more side effects than a placebo shouldn't be surprising - we're talking about a placebo here! Ultimately, if the benefits outweigh the side effects, the product should be considered viable. This is the job of the FDA.
That being said, the side effects are substantial and should be viewed as a significant barrier.
3) At-the-market offerings (ATMs) are volume-limited. You can't just file for a $70M ATM and raise $70M the way you can with a registered direct offering (RD), a confidentially marketed public offering (CMPO) or private investment in public equity (PIPE).
Defensible data points notwithstanding, the original report provided plenty of valid arguments for shorting CNDO:
1) First and foremost, the original report harshly indicted Lindsay Rosenwald, who was referred to as CNDO's "master puppeteer". Indeed, our contacts reported having heard a lot about Rosenwald and not much of it was good. To be fair, most of our contacts' commentary was focused on reputation, not indisputable fact. A bit of levity was also sprinkled in, "Say what you will, the guy has the best office view in Midtown, by far."
2) How are regulators going to view whipworm eggs? How do you control the dose? What colony produces the eggs? The FDA is a stickler for manufacturing consistency. This issue alone is likely a big mess in the making.
3) In the mid-90s, several high-priced biotech companies went bust. Over 90% of drugs that enter clinical trials fail. In other words, the odds are stacked against CNDO whether the company is fraudulent or not.
4) This quote hammered a key point home: "It is virtually indisputable that a therapy with this origin will turn people off. I honestly don't think I've seen something like this in a while. There is no arguing that the end-market is potentially huge, but people "forget" that only the most desperate patient with an MD that has exhausted every other option would ever try this, in my opinion. So, the actual market opportunity is likely only a tiny fraction of that otherwise huge market."
Taking everything into account, we concluded that The Street Sweeper presented a strong and compelling case. The cons certainly outweighed the pros and our contacts made it clear that there are definitely some sketchy firms in the industry.
Is CNDO one of them? We can't say with certainty. However, the name of the game is risk and reward. The Street Sweeper's report may have come across as one-sided, but after doing our own legwork, we can understand why. Accordingly, we feel that the balance of risk and reward is not good for those who own the stock. Rather, it falls squarely in favor of the short sellers.