Applicability Of Short Squeezes Of 4 Pharma Stocks

by: R.G.Analytics

My last column comparing the FDA processes on these four stocks, Avanir (AVNR), Arena (ARNA), Vivus (VVUS), Dendreon (DNDN) was well received (over 17000 views within 2 trading days).

Publicity of Short vs. Long Positions

Short squeezes in biotech/pharma are not uncommon because many short sellers thrive on companies whose development cycle is very long and capital intensive. Financiers who lend biopharma companies money sometimes have warrants and short against those warrants (covered short), and large shorts have the advantage over large longs that their identity is protected by the SEC so neither the company nor other investors really know who large shorts are. It's not odd to argue that shorts are enemies of a company as their interest lies in the reduced valuation.

If a company knows its own enemies it can be in a better shape in dealing with them (e.g. not entering new financing agreements). Many arguments have been presented to the SEC for curbing short sales including a pre-borrow requirement but while there have been improvements in enforcements in the last couple of years more can be done. It is positive that the SEC has taken enforcing short sale rules more seriously that it appeared to do five to ten years ago.

An SEC roundtable on short selling revealed that the key argument of large shorts against being public is concern over what they call "front running". Of course it can be argued that front running could provide an unfair competitive environment for longs as well but for now the SEC doesn't consider that good enough of a reason to publicize who large shorts are just as large long positions are public information.

Shorting in Biotech: Avanir, Vivus, Arena, Dendreon

It is common wisdom to short a PDUFA date, and then short a launch done by a small bio-pharma. Vivus and Arena's launches are both awaiting FDA approval. Many argue that Arena is in a better shape for the launch than Vivus because of its existing manufacturing facility and marketing agreement. While both companies may be target of pre-PDUFA shorting, Vivus has a higher chance of being a target of pre-launch shorting like Avanir was. Like Arena, Dendreon already had the infrastructure in place for their launch and therefore were not target of pre-launch shorting. Avanir had to build their sales infrastructure post approval and was heavily shorted in hopes of a failing launch but Avanir has proven to have been highly successful in both building a world-class sales organization and significantly tapping into the large potential market for Nuedexta.

Shorts Can Be Wrong

According to the 29 February 2012 report, AVNR has a short interest of 25,343,278 and ARNA a short interest of 25,332,031 shares.

I had an email from Martin Shkreli last week where he reiterated his bearishness on both Arena and Avanir. Market doesn't seem to agree with Mr. Shkreli. Both AVNR and ARNA have shown recent strength up significantly YTD (AVNR is up over 95% since December), and poised for further gains. Shorts sometimes make the wrong calls. Shkreli was wrong about Avanir and Arena's prospects just as he was wrong about Avanir's patents' strength.

Arena, Vivus, Dendreon:

The day the Seeking Alpha article came out (and no other news) Arena's shares skyrocketed over 18% adding $66 Million to the company's market cap (SA's readership should not be under-estimated :) Many believe what we saw on 23 March 2012 was a short squeeze given the large short interest on Arena. The article was quoted in other publications, I received many emails crediting the move to the article, and rezamusic had many visitors.

Last month Vivus more than doubled on positive Adcom news, a gain of 125% and a large short position fueled the rally.

Dendreon saw a short squeeze twice in its history, once before the 2007 Adcom and once after receiving approval. In the first case the shares went up over 400% -- a biotech short squeeze dream.

Avanir's due for a short squeeze:

Avanir's key challenge after getting approval was to build a sales organization. Soon after launch the company realized an opportunity in Long Term Care and focused on it. Currently about 50% of sales are generated from LTC. With strong month over month numbers, prospects for the company have never been better.

Shorts were wrong in predicting that the FDA would turn down Nuedexta, they were wrong in claiming PBA is not real. They didn't consider the huge off label potential for Nuedexta, they were wrong in predicting a failed launch, and with the thin trading volume, any significant news, or news at all, or just a Seeking Alpha article :) can trigger a short squeeze like we've witnessed in the case of ARNA. When shorts lose balance they run for cover and it can get ugly very quickly when those who don't have shares and want some compete with those who absolutely have to buy because not only they don't have shares but they owe shares.

Avanir is close to getting approval for marketing across the European Union. The company has hinted a partnership is in the works. And company has maintained that it has many options that dilution for financing if it ever needs it. With no significant number of options and no warrants outstanding over 25 Million shorted shares will fuel a rally and short squeeze as company gets closer to European approval. The up front cash from a European or ROW partner can boost the already strong cash position (over $75MM as of end of last quarter) and fuel to the short squeeze fire.

At the same time ongoing trials for other indications than PBA continue to expand the potential market. There are already reports of off-label use which should increase as the ongoing trials on a variety of other applications for Nuedexta progress further. Neuropathic Pain market is huge and a perfect target for Nuedexta. A doctor recently wrote:

Saw my patient with MS, mild PBA and central pain back in the office in followup this week. She admitted to me that she simply didn't realize the extent of her PBA and its impact on her social interactions. She was quite pleased. She also marveled at how she (and her physical therapist) felt noticeably stronger on Nuedexta. Can't explain that one... Her pain is significantly better.

There are plenty of patient testimonials for Nuedexta, many of which show none if very little side effects:

I have been taking Nuedexta for 6 weeks now and have noticed a huge improvement in my crying outbursts. This is the first drug that has helped me. I'm 46 and have suffered with PBA for 30 years.

Another patient said:

Nuedexta gave me my life back.

One of the many off label uses of Nuedexta (and upcoming trial) is for agitation associated with neurologic disorders. One doctor who has used Nuedexta off-label wrote:

His response to treatment included less anger & elimination of 3 other medication.

The good safety profile makes Nuedexta an attractive alternative to other medicines with severed side effects. One doctor wrote:

I have treated dozens of patients who have failed SSRI's and many of whom also had side effects that they loathed to put up with... Safe, effective, quick onset, well-tolerated, FDA approved; absent the side effects of the old SSRI and TCA's (and the risks); and besides, I'm usually able to stop 1-3 other meds.

Just prescribed Nuedexta to metastatic brain tumour patient last week and the drug worked the next day: it stopped 10 episodes a day, without side effects.

Nuedexta, as known in some circles as "the aspirin of neurology" provides a tremendous growth opportunity for Avanir and fully justifies Summer Street's $11 price target. While Avanir has made it very clear that it does not discuss promote nor recommends off label use, the list of potential uses of Nuedexta is long and includes: ALS, MS, Stroke, TBI, Parkinson's, Alzheimer's, Central Neuropathic Pain, Peripheral Neuropathic Pain, Agitation, Anger, Irritability, Emotional Lability other than PBA, Autism, Dementia, Somatic Pain, Bipolar, Depression, Disorders of Speech Swallowing, Tic Disorders, Migranes, IBS, Anxiety, Compulsive Disorders, and many other conditions.

It is not surprising that institutional ownership has been steadily rising to over 70% of the outstanding shares. T. Rowe Price and Fidelity both recently added over 1,000,000 shares of AVNR to their portfolios.

The Arena short squeeze started the day the Seeking Alpha article making that prediction was published. I believe Avanir is next. Dendreon and Vivus have already had their shorts shaken up. Avanir's shorts have been hanging on but soon their grip on the stock evaporate and turn into a "run for cover" short squeeze.

This article reflects my opinion based on my research. Please do your own research before making investment decisions.

Disclosure: I am long AVNR, ARNA.